Why You Need to Understand Stock Float

The stock float is one of the metrics that have the power to greatly influence the price of the stock. So make sure you get familiar with it if you plan to become a trader.

What Is a Stock Float?

To put it simply, the float of a certain stock is the measure of the number of shares that can actually be traded. So in a way, this metric is actually a measure of liquidity. And understanding the float allows the traders to predict the potential volatility of the stock.

General Recommendations Regarding Stock Float

If a stock has a high float, that means that it is more likely for traders to accurately predict its behavior. A large number of tradable shares means that the liquidity of the stock can support significant moves. With high-float stocks, such moves don’t impact the stock too much. However, low-float stocks can experience moves as huge as 40%.

For that reason, it is not always the best idea to trade low-float stocks. The price is reactive and the stock itself can be very volatile. That is especially true during the formative years of the life of a company.

A trader who knows what to look for can measure the goodwill of a company by looking at the float. Moreover, even a novice can measure the interest of the public in the stock. So in most cases, it is advisable to trade high-float stocks.

What Are the Differences Between Free-Float Market Cap and Market Cap

We can’t talk about the stock float without mentioning market capitalization. When you first start researching stocks, you might notice that company categories revolve around the market caps of those companies.

In essence, the market capitalization is a measure of the size of a company. Basically, it is the total value of the outstanding shares of stocks of a company. Those shares include both the publicly traded shares and the shares that are held by insiders.

Calculating the market capitalization of a company is rather straightforward. All you have to do is multiply the number of the outstanding shares of a company by the stock price. Allow us to illustrate with a simple example.

Let’s imagine a nameless company that has 100 shares outstanding. Now, let’s imagine that the company is trading at a stock price of $5. We can now calculate the market share by simply multiplying those two numbers. In our case, the number comes out at $500. Naturally, no company will trade with only 100 shares. In fact, stocks that have a market value of fewer than 250 million dollars are considered to be micro-cap stocks. And to enter a large-cap stock category, companies have to have a market value of over 10 billion dollars.

Now that we have an understanding of what market capitalization is, we can look back at the float. The float only numbers the outstanding shares that the public can trade. That means that the restricted stocks don’t enter the float.

To calculate the float of a company, we have to remove the inside trading shares. After all, they are of no use to the public, and they do reduce the liquidity of the stock. For that reason, major indexes prefer measuring the free float instead of the market cap.

Manipulating the Stock Price with Float

The market follows the rules of supply and demand. So if there are fewer shares available while the demand doesn’t change, the price will go up. And as the float is the measure of shares that the public can trade, people start wondering if the company can manipulate the float and thus impact the stock price.

While high-float stocks are more attractive for traders, reducing the float will actually increase the price. Studies have shown that companies are capable of manipulating the float to impact the price of a stock.

Companies can increase the float by issuing new shares. Conversely, they can reduce it by organizing a share buyback. Alternatively, some companies can use a stock split to impact the float.

Another way for companies to influence the float is through insider activity. In the case of a significant number of exercised options, the insider actions can change the stock float.

Furthermore, companies can simply choose to increase the float by selling inside shares. In most cases, companies do so in order to raise cash. However, that doesn’t exclude the possibility of ulterior motives.

And for that reason, investors should be wary of potential manipulations.